Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

The Drug Reimportation Disaster

State-imposed pricing is not natural law. Expect Canada to have a problem supplying all those drugs.

Municipalities and states around the country have their teeth in the greedy hides of the big pharmaceutical companies, and they're going to punish them for charging exorbitant prices for drugs.

How? Easy enough. They'll import prescription drugs from Canada, where the same products made by the same (mostly American) companies cost consumers substantially less. Congress is pressuring President Bush to allow reimportation, and we have the folks at FOX News saying that Americans would save from "30 to 300 percent of the cost." I'll let someone else take the folks at Fox(NYSE:FOX) to task for their abysmal math skills.

All these assumptions are great, except that reimportation won't work, not on a large scale. And if it did work, it would be a disaster for health care here and in Canada. Unfortunately for the states and cities seeking to reimport, what works on an individual scale cannot work writ large.

We've already seen the first shot fired, as Pfizer(NYSE:PFE) -- as Brian Gorman noted in his fantastic article yesterday -- cut off supplies to several Canadian wholesalers. I disagree with the notion that pharmaceutical companies would allow massive reimportation from Canada to have an impact on their bread-and-butter U.S. market. When push comes to shove, Canada -- not the drug companies -- will feel the pinch.

Canada, by population, is one-tenth the size of the U.S. Its market for drugs is substantially smaller than the $200 billion worth consumed here. And here's the thing: Drugs are not "cheaper" in Canada. They're made less expensive for the consumer by the state's imposition of substantial price controls. The "cost" of a pill consumed in Canada is identical to one consumed in this country.

So, you know who's going to shut this down? One of two entities: the drug companies themselves or the Canadian government.

It works this way: Pfizer knows how much Viagra is being consumed in Canada. At some point, it can say, "We know how much Canadians consume by themselves, and it's substantially lower than the amount we're selling there now. We'll solve this by limiting the amount of Viagra we send to Canada to the amount they were consuming in 2003."

Seriously, a company the size of Merck(NYSE:MRK) doesn't need to sell to Canada. And if its operations in Canada are cannibalizing its U.S. market, don't think for a second that the company wouldn't demand that Canada fix the problem itself, lest Merck sell to Canadian sources all of its drugs for the same exact price that it sells them in the U.S. Given the endgame choice between putting its foot down and demanding that Canada control its borders or allowing its share price to crash due to billions in profits rushing out the door, is it that hard to figure what Merck would do?

Merck doesn't need Canada. Bristol-MyersSquibb(NYSE:BMY) doesn't need Canada. GlaxoSmithKline(NYSE:GSK) doesn't need Canada. These companies sell to Canada cheaply because they can make it up elsewhere -- in the U.S. When "elsewhere" is at risk, and Canadian reimportation's the cause, then Canada may have a problem. If Merck caps the amount of Zocor it ships to Canada, who do you think is going to have priority access: a clinic in Moose Jaw or the city of Seattle?

None of this, of course, is really fair to Canada, except that by artificially setting prices, the Canadian government puts itself at risk of having suppliers say that selling there isn't worth it. Do we really believe that Canada will let its own access to these drugs be put at risk?

This isn't a very good social outcome, but Canada, along with every other country that artificially puts a ceiling on its drug prices, enjoys what's called a "free rider" benefit on the backs of U.S. drug consumers. Drug companies are able to sell medications more cheaply elsewhere because they can charge what the market will bear in the U.S. Our consumers bear the bulk of the cost it takes not just to produce and distribute drugs -- that's generally pretty cheap -- but to develop them in the first place.

One need only look at the problems facing orphan diseases -- ones that no drug company seeks to address because the market is simply economically too small to make the capital outlays worthwhile. What happens when the lower prices drug companies can count on push more diseases past being too small to address? Even a company that focuses on these smaller markets, like King Pharmaceuticals(NYSE:KG), isn't going to expend the effort if it cannot reasonably make a profit.

I don't really know, but I do know one thing: We have -- once again -- a whole slew of people who are looking at an economic issue on a single step basis without thinking about any of the additional consequences, or worse, the causes. Too easy to point the finger, I guess.

What do you think? And can you help FOX News with its abysmal math skills? Take it to ourPharmaceuticalsdiscussion board.

Bill Mann doesn't own any companies mentioned above. Please view his profile for his holdings.